management’s discussion and analysis · interim report 2011 boc hong kong (holdings) limited 11...

8 BOC Hong Kong (Holdings) Limited Interim Report 2011

MANAgEMENT’S DISCuSSION AND ANAlySIS

The following sections provide metrics and analytics of the Group’s performance, financial positions, and risk management.

These should be read in conjunction with the financial information included in this Interim Report.

FINANCIAl PERFORMANCE AND CONDITION IN BRIEFThe following table is a summary of the Group’s key financial results for the first half of 2011 with a comparison with the

previous two half-yearly periods.

Financial Indicators 2011 First Half Performance

1. Profit Attributable to Shareholders

HK$’m

1H2010 1H2011

7,1929,004

11,993

2H2010

Profit attributable to shareholders

• TheGroup’sprofitcontinuedtogrow.

Profit attributable to shareholders was

HK$11,993 million, up HK$4,801

million, or 66.8%, year-on-year.

• The Group recorded a net recovery

from the underlying collateral of

the Lehman Brothers Minibonds

amounting to HK$2,854 million*.

• Should the impact of the above-

mentioned net recovery together with

the expenses of Lehman Brothers-

related products (hereafter called

“impact of Lehman Brothers-related

products”) be excluded, profit

attributable to shareholders would

have been HK$9,679 million, up

HK$2,423 million or 33.4% year-on-

year, a record high since listing.

* Refer to Note 2 and Note 11 to the Interim

Financial Information.

2. Return on Average Shareholders’ Equity (“ROE”)1

%

13.5616.14

19.88

1H2010 1H20112H2010

ROE

• ROEwas19.88%,increasingby6.32

percentage points year-on-year.

• Excluding the impact of the Lehman

Brothers-related products, ROE

would have been 15.75%, up 2.49

percentage points year-on-year.

3. Return on Average Total Assets (“ROA”)2

%

1.17 1.241.33

1H2010 1H20112H2010

ROA

• ROAwas1.33%,up0.16percentage

point year-on-year.

• Excluding the impact of the Lehman

Brothers-related products, ROA

would have been 1.07%, down 0.11

percentage point year-on-year. The

decrease was due to the expansion of

the Group’s average asset base with

the growth of advances to customers

and RMB interbank balances and

placements.

9Interim Report 2011 BOC Hong Kong (Holdings) Limited



4. Net Interest Margin (“NIM”)

%

1.581.42

1.21

1H2010 1H20112H2010

NIM

• NIMwas1.21%,down37basispoints

year-on-year due to the increase in

market rate-based loans under the

low interest rate environment, intense

competition for deposits and the

diluting effect of RMB business in

Hong Kong.

• Excluding the estimated impact of

RMB clearing services performed by

BOCHK, NIM would have been 1.48%,

down 16 basis points year-on-year.

5. Cost-to-Income Ratio (“CIR”)

%

36.1533.74

13.18

1H2010 1H20112H2010

CIR

• CIR was 13.18%, down 22.97

percentage points year-on-year, mainly

due to the net recovery from the

underlying collateral of the Lehman

Brothers Minibonds.

• Should the impact of the Lehman

Brothers-related products be excluded,

CIR would have been 31.92%, down

3.62 percentage points year-on-year.

6. Deposits from Customers (including structured deposits) 892.7

1,027.31,104.0

2010.06.30 2011.06.302010.12.31

HK$’bn Deposits from Customers

• Total deposits increased by 7.5%

from the end of 2010, with the

strong performance of RMB and USD

deposits.

7. Advances to Customers

571.5 613.2672.9

2010.06.30 2011.06.302010.12.31

HK$’bn Advances to Customers

• Advancestocustomersgrewhealthily

by 9.7% from the end of 2010. The

Group also improved the pricing of

loans.

8. Classified or Impaired loan Ratio3

%

0.23

0.14

0.10

2010.06.30 2011.06.302010.12.31

Classified or Impaired loan Ratio

• Classifiedor impaired loan ratiowas

0.10%, down 0.04 percentage point

from the end of 2010.

• Formation of new classified loans

remained at a low level, representing

approximately 0.03% of total loans.




9. Capital Adequacy Ratio (“CAR”)4

%

16.17 16.1417.62

2010.06.30 2011.06.302010.12.31

CAR

• CARwasmaintainedatahighlevelof

17.62%.

• Corecapitalratiowas12.87%.

10. Average liquidity Ratio %

37.81 39.7436.38

1H2010 1H20112H2010

Average liquidity Ratio

• Averageliquidityratiowasatahealthy

level of 36.38%.

1 Return on Average Shareholders’ Equity of the Company as defined in “Financial Highlights”.

2 Return on Average Total Assets as defined in “Financial Highlights”.

3 Classified or impaired loans represent advances which have been classified as “substandard”, “doubtful” or “loss” under the Group’s classification of loan

quality, or individually assessed to be impaired.

4 Capital adequacy ratio is computed on the consolidated basis that comprises the positions of BOCHK and certain subsidiaries specified by the HKMA for

its regulatory purposes and in accordance with the Banking (Capital) Rules. The Group adopted the foundation internal ratings-based (“FIRB”) approach

to calculate credit risk and BOCHK adopted the internal models approach to calculate general market risk for interest rate and exchange rate exposures as

at 30 June 2011, as opposed to the standardised (credit risk) (“STC”) approach and standardised market risk (“STM”) approach that were used as at 31

December 2010. As a result of the change in the basis used, the capital ratios shown above are not directly comparable.



ECONOMIC BACKgROuND AND OPERATINg ENvIRONMENTThe Hong Kong economy continued to recover despite

uncertainties such as the European debt crisis and the

negative impact of the earthquake tragedy in Japan.

Supported by strong private consumption and merchandise

exports, Hong Kong’s annualised GDP grew by 6.3% in

the first half of the year. The labour market continued

to improve, with the unemployment rate falling to 3.5%

in the second quarter of the year. Inflationary pressures

increased, driving up the overall consumer prices by 5.6%

in June 2011 compared to a year ago. Market interest

rates remained low, with the average 1-month HIBOR

staying at around 0.18% in the first half of 2011.

The property market remained buoyant. The average

price of private domestic properties showed an increase

of 14.0% in the first half of 2011, following a 21.0%

increase in 2010. Measures were taken by the government

and regulatory body to ensure a more stable property

market and mortgage environment. These included the

Government’s plan to increase land supply and the Hong

Kong Monetary Authority’s new guidelines to lower the

loan-to-value ratio for mortgage loans. Meanwhile, in

view of higher funding costs, banks raised the HIBOR-

based mortgage rates several times in the first half of

the year.

The Hong Kong stock market was adversely affected by

the European debt crisis, concern over a slowdown in

the global economy and the Mainland’s credit tightening

policy. As a result, investment sentiments turned weak in

the first half.

The growth momentum of loans remained strong in

the market due to the rise in demand, which was partly

caused by the tightening of credit in the Mainland.

Meanwhile, competition for deposits intensified and led

to a rise in funding costs.

The offshore RMB market in Hong Kong expanded in

an incremental and orderly manner. The demands for

RMB trade settlement grew rapidly while RMB deposits

in Hong Kong saw solid growth. Permission was granted

to offshore monetary authorities and eligible banks to

access the Mainland’s RMB bond market. With regard to

the RMB clearing bank business in Hong Kong, a major

development was that the RMB Fiduciary Account Service

was introduced to help Participating Banks to better

manage their credit exposure to the Clearing Bank.

In summary, the operating environment for the banking

industry remained challenging in the first half of 2011.

Banks were faced with the narrowing of net interest

margins. Inflationary pressure also put pressure on banks’

profitability. Nevertheless, the surging demand for loans

and the rapid expansion of RMB market presented

significant business opportunities for the banking sector.

Looking ahead to the remainder of the year, the Hong

Kong economy is still subject to uncertainties in view

of the unresolved European debt crisis and sluggish

economic recovery in the United States. Lately, the global

financial markets reeled amid concern over worsening

global economic outlook triggered by the downgrade of

the US sovereign credit rating. The potential impact of

these factors on the financial markets and the banking

sector cannot be ignored.



CONSOlIDATED FINANCIAl REvIEWFinancial Highlights

HK$’m, except percentage amounts

Half-year ended 30 June

2011

Half-year ended

31 December

2010

Half-year ended

30 June

2010

Net interest income 10,205 9,770 8,964

Other operating income 4,921 5,197 3,577

Net operating income before impairment allowances 15,126 14,967 12,541

Operating expenses (1,993) (5,050) (4,534)

Operating profit before impairment allowances 13,133 9,917 8,007

Net (charge)/reversal of impairment allowances (30) 154 161

Others 1,484 904 599

Profit before taxation 14,587 10,975 8,767

Profit attributable to equity holders of the Company 11,993 9,004 7,192

Earnings per share (HK$) 1.1343 0.8517 0.6802

Return on average total assets 1.33% 1.24% 1.17%

Return on average shareholders’ equity 19.88% 16.14% 13.56%

Net interest margin 1.21% 1.42% 1.58%

Non-interest income ratio 32.53% 34.72% 28.52%

Cost-to-income ratio 13.18% 33.74% 36.15%

In the first half of 2011, the Group continued to strive for

balanced growth that supports long-term development.

By tapping into opportunities arising from the economic

recovery and the fast-expanding offshore RMB market, the

Group achieved encouraging results. At the same time, it

stayed alert to various risks in its operating environment

and continued to exercise prudent risk management.

Compared to the first half of 2010, the Group’s net

operating income before impairment allowances increased

by HK$2,585 million or 20.6% to HK$15,126 million. The

increase was mainly attributable to higher net interest

income, net fee and commission income as well as

net trading gain. Operating expenses decreased sharply

primarily due to the net recovery from the underlying

collateral of the Lehman Brothers Minibonds. The Group

recorded a modest amount of net charge of impairment

allowances. The net gain on property revaluation also rose

year-on-year. The Group’s profit attributable to equity

holders increased by HK$4,801 million, or 66.8%, to

HK$11,993 million. Earnings per share were HK$1.1343,

up HK$0.4541 from the same period last year. ROA and

ROE stood at 1.33% and 19.88% respectively.

As compared to the second half of 2010, the Group’s

profit attributable to equity holders increased by HK$2,989

million, or 33.2% mainly due to the growth in net

operating income, the net recovery from the underlying

collateral of the Lehman Brothers Minibonds and the

increase in net gain on property revaluation. Both net

interest income and net fee and commission income rose,

while net trading gain registered a decline due to mark-to-

market changes of certain financial instruments.



Analyses of the Group’s financial performance and business operations are set out in the following sections.

Net Interest Income and Margin



2011

Half-year ended

31 December

2010

Half-year ended

30 June

2010

Interest income 15,156 12,778 10,671

Interest expense (4,951) (3,008) (1,707)

Net interest income 10,205 9,770 8,964

Average interest-earning assets 1,698,704 1,367,524 1,142,383

Net interest spread 1.14% 1.35% 1.53%

Net interest margin 1.21% 1.42% 1.58%

Adjusted net interest margin*

(adjusted for clearing bank function) 1.48% 1.55% 1.64%

* The adjusted net interest margin excludes the estimated impact of RMB clearing services performed by BOCHK. Since December 2003, the Bank has been

appointed as the clearing bank to provide RMB clearing services in Hong Kong.

Compared to the first half of 2010, the Group’s net

interest income increased by HK$1,241 million or 13.8%

on the back of growth in average interest-earning assets.

Net interest income continued to be compressed by the

narrowing of net interest spread.

In the first half of 2011, average interest-earning assets

increased by HK$556,321 million or 48.7% year-on-

year, mainly supported by the increase in both customer

deposits and RMB funds from the clearing bank business.

Net interest margin was 1.21%, down 37 basis points

compared to the first half of 2010. Should the estimated

impact of BOCHK’s RMB clearing function in Hong Kong

be excluded, the adjusted net interest margin would have

been 1.48%, down 16 basis points.



The summary below shows the average balances and average interest rates of individual categories of assets and

liabilities:

Half-year ended30 June 2011

Half-year ended

31 December 2010

Half-year ended

30 June 2010

Averagebalance

Averageyield

Average

balance

Average

yield

Average

balance

Average

yield

ASSETS HK$’m % HK$’m % HK$’m %

Balances and placements with

banks and other financial institutions 628,593 1.21 341,069 1.15 211,521 0.95

Debt securities investments 423,344 2.36 418,023 2.20 369,306 2.28

Loans and advances to customers 630,343 2.02 593,731 2.02 547,281 2.00

Other interest-earning assets 16,424 1.74 14,701 1.48 14,275 1.26

Total interest-earning assets 1,698,704 1.80 1,367,524 1.85 1,142,383 1.88

Non interest-earning assets 160,827 – 136,300 – 116,018 –

Total assets 1,859,531 1.64 1,503,824 1.69 1,258,401 1.71

Half-year ended30 June 2011

Half-year ended

31 December 2010

Half-year ended

30 June 2010

Averagebalance

Averagerate

Average

balance

Average

rate

Average

balance

Average

rate

lIABIlITIES HK$’m % HK$’m % HK$’m %

Deposits and balances from banks and

other financial institutions 441,309 0.89 179,419 0.87 105,914 0.58

Current, savings and fixed deposits 1,000,360 0.53 910,007 0.41 807,886 0.27

Subordinated liabilities 27,094 2.11 27,840 1.68 26,373 2.10

Other interest-bearing liabilities 41,910 0.40 68,091 0.35 39,572 0.31

Total interest-bearing liabilities 1,510,673 0.66 1,185,357 0.50 979,745 0.35

Non interest-bearing deposits 67,777 – 76,078 – 57,847 –

Shareholders’ funds# and

non interest-bearing liabilities 281,081 – 242,389 – 220,809 –

Total liabilities 1,859,531 0.54 1,503,824 0.40 1,258,401 0.27

# Shareholders’ funds represent capital and reserves attributable to the equity holders of the Company.

Average yield of interest-earning assets fell by 8 basis

points while the average rate of interest-bearing liabilities

increased by 31 basis points. As a result, the net interest

spread decreased year-on-year by 39 basis points.

Contribution from net free fund increased by 2 basis

points.

The increased proportion of loans and advances with

pricing based on interbank market rates (hereafter called

“market rate-based loans”) put pressure on asset yield.

Meanwhile, the local RMB deposits (including those

arising from the clearing bank business and the Group’s

customers) grew significantly. However, the spread

remained low as the use of offshore RMB fund was

still limited. Deposit costs also rose amid keen market

competition.



The adverse impact from the above-mentioned factors was

moderated by the Group’s growth in higher-yielding assets

such as loans and advances to customers. The Group also

focused on enhancing the pricing of its corporate lending

and improved the pricing of new corporate loans during

the period. In the second quarter of 2011, the Group

raised the pricing of HIBOR-based residential mortgage

loans several times.

Compared to the second half of 2010, net interest income

increased by HK$435 million or 4.5% primarily due to the

growth in average interest-earning assets. Net interest

margin was 1.21%, down 21 basis points. Should the

estimated impact of BOCHK’s RMB clearing function in

Hong Kong be excluded, the adjusted net interest margin

would have been 1.48%, down 7 basis points.

Persistently low market interest rates, increased deposit

costs, higher proportion of market rate-based loans

coupled with the growth in local RMB assets put pressure

on the Group’s net interest margin. These negative factors

were partly counterbalanced by the growth in higher-

yielding assets such as loans and advances to customers

and debt securities investments.

Net Fee and Commission Income

HK$’m


2011

Half-year ended

31 December

2010

Half-year ended

30 June

2010

Securities brokerage 1,485 1,829 1,509

Credit cards 1,189 1,100 903

Insurance 610 341 220

Loan commissions 588 338 623

Bills commissions 418 380 371

Payment services 303 296 272

Currency exchange 224 207 125

Funds distribution 176 93 67

Trust services 123 108 98

Safe deposit box 107 97 103

Others 209 209 190

Fee and commission income 5,432 4,998 4,481

Fee and commission expenses (1,446) (1,351) (1,084)

Net fee and commission income 3,986 3,647 3,397

Net fee and commission income rose by HK$589 million

or 17.3% year-on-year to HK$3,986 million, primarily

due to the increase of HK$390 million or 177.3% in

commission income from the insurance business and

HK$109 million or 162.7% from fund distribution. The

commission income from insurance, comprising life

insurance, general insurance and reinsurance, grew with

the rise in business volume. To boost the sale of funds,

the Group stepped up its marketing efforts and enhanced

its customer services through an investment product

specialist team. Fee income from credit cards grew as

the cardholder spending and merchant acquiring volume

increased by 26.2% and 38.4% respectively. Fee and

commission income from currency exchange, bills, trusts

and payment services also recorded satisfactory growth.

Fee and commission expenses rose by HK$362 million or

33.4%, mainly due to the increases in credit cards and

insurance commission expenses.

Compared to the second half of 2010, net fee and

commission income increased by HK$339 million or 9.3%.

The growth was mainly driven by the HK$250 million or

74.0% increase in loan commissions and HK$269 million

or 78.9% rise in insurance commission income. At the

same time, fee income from credit card business rose

by HK$89 million or 8.1% while commission from fund

distribution grew by HK$83 million or 89.2%. Fee income

from other traditional businesses such as bills, currency

exchange and trust services also grew. Fee income from

securities brokerage declined by HK$344 million or 18.8%

as investment sentiments turned weaker in the first half

of 2011.



Net Trading Gain/(Loss)

HK$’m


2011

Half-year ended

31 December

2010

Half-year ended

30 June

2010

Foreign exchange and foreign exchange products 662 649 350

Interest rate instruments and items under fair value

hedge (4) 686 (424)

Equity instruments 32 12 (20)

Commodities 71 58 58

Net trading gain/(loss) 761 1,405 (36)

Net trading gain was HK$761 million, increasing by

HK$797 million from the first half of 2010. The growth

was mainly driven by the increase in net trading gain from

foreign exchange and related products as well as the

decrease in net trading loss of interest rate instruments

and items under fair value hedge. Net trading gain from

foreign exchange and related products rose by HK$312

million or 89.1%, which was mainly attributable to the

fast-growing currency exchange activities. The decrease

in net trading loss from interest rate instruments and

items under fair value hedge was primarily due to the

change in mark-to-market values of certain interest rate

swap contracts.

Compared to the second half of 2010, net trading gain

declined by HK$644 million or 45.8%. The decrease was

mainly due to the decline in mark-to-market gain on

certain interest rate instruments.

Net Gain/(Loss) on Financial Instruments Designated at Fair Value through Profit or Loss

HK$’m


2011

Half-year ended

31 December

2010

Half-year ended

30 June

2010

Banking business of the Group 18 (5) 49

BOC Life 380 107 591

Net gain on financial instruments designated

at fair value through profit or loss 398 102 640

The Group recorded a net gain of HK$398 million on

financial instruments designated at fair value through

profit or loss in the first half of 2011, falling by HK$242

million or 37.8% from the same period last year. The

decrease was mainly due to the decline in mark-to-market

gain on certain debt securities of BOC Life caused by the

movement of market interest rates. These mark-to-market

changes were substantially offset by the corresponding

changes in policy reserves, as reflected in the changes in

net insurance benefits and claims which were attributable

to the movement of market interest rates.

Compared to the second half of 2010, net gain on

financial instruments designated at fair value through

profit or loss increased by HK$296 million. The growth

was mainly attributable to the mark-to-market gain of

certain debt securities investments of BOC Life.



Operating Expenses



2011

Half-year ended

31 December

2010

Half-year ended

30 June

2010

Staff costs 2,740 2,831 2,526

Premises and equipment expenses

(excluding depreciation) 610 627 574

Depreciation on owned fixed assets 614 575 556

Other operating expenses 864 1,005 801

Core operating expenses 4,828 5,038 4,457

Impact of Lehman Brothers-related products* (2,835) 12 77

Total operating expenses 1,993 5,050 4,534

Cost-to-income ratio 13.18% 33.74% 36.15%

Core cost-to-income ratio 31.92% 33.66% 35.54%

* For details, see Note 2 and Note 11 to the Interim Financial Information.

Net (Charge)/Reversal of Loan Impairment Allowances

HK$’m


2011

Half-year ended

31 December

2010

Half-year ended

30 June

2010

Net reversal/(charge) of allowances before recoveries

– individual assessment 42 93 56

– collective assessment (295) (272) (256)

Recoveries 216 155 294

Net (charge)/reversal of loan impairment allowances (37) (24) 94

The Group’s total operating expenses dropped by

HK$2,541 million, or 56.0%, to HK$1,993 million. The

decrease was mainly due to the net recovery of HK$2,854

million from the underlying collateral of the Lehman

Brothers Minibonds. The Group’s core operating expenses

increased by HK$371 million or 8.3%. In the first half

of 2011, the Group focused on enhancing operational

efficiency and investing for business development.

Staff costs increased by HK$214 million or 8.5%, mainly

due to the increase in headcount, in particular front-

line staff, and higher salaries and performance-related

remuneration. Compared to 30 June 2010, headcount

measured in full-time equivalents rose by 675 to 14,104

as at 30 June 2011.

Premises and equipment expenses increased by HK$36

million or 6.3%, as a result of higher rental for branches

in Hong Kong and the Mainland. Depreciation on owned

fixed assets rose by HK$58 million or 10.4%, which was

attributable to larger depreciation charge on premises

following the upward revaluation.

Other operating expenses rose by HK$63 million or 7.9%

mainly due to higher marketing and promotion expenses

as well as expenses connected with the growth in business

volume.

Compared to the second half of 2010, operating expenses

declined by HK$3,057 million or 60.5%. This was largely

due to the impact of the Lehman Brothers-related products

as well as lower staff costs and promotional expenses in

the first half of 2011.



The Group registered a modest amount of net charge of

loan impairment allowances of HK$37 million in the first

half of 2011.

As the economic environment continued to improve, the

Group recorded a net reversal of individual impairment

allowances before recoveries in the current period

amounting to HK$42 million. Meanwhile, net charge

of collective impairment allowances before recoveries

increased by HK$39 million or 15.2% year-on-year to

HK$295 million mainly due to loan growth and the

periodic review of the parameter values in the assessment

model.

Compared to the second half of 2010, net charge of loan

impairment allowances increased by HK$13 million or

54.2%. Net charge of collective impairment allowances

before recoveries increased mainly due to loan growth in

the first half of 2011.

Financial Position


At 30 June 2011

At 31 December

2010

Cash and balances with banks and other financial institutions 419,231 415,812

Placements with banks and other financial institutions maturing between

one and twelve months 89,618 39,499

Hong Kong SAR Government certificates of indebtedness 54,460 46,990

Securities investments1 441,973 430,060

Advances and other accounts 719,500 645,424

Fixed assets and investment properties 47,774 41,391

Other assets2 57,823 41,864

Total assets 1,830,379 1,661,040

Hong Kong SAR currency notes in circulation 54,460 46,990

Deposits and balances from banks and other financial institutions 386,904 313,784

Deposits from customers 1,103,435 1,027,033

Insurance contract liabilities 43,045 39,807

Other accounts and provisions3 85,074 88,260

Subordinated liabilities4 27,838 26,877

Total liabilities 1,700,756 1,542,751

Non-controlling interests 3,460 3,108

Capital and reserves attributable to the equity holders of the Company 126,163 115,181

Total liabilities and equity 1,830,379 1,661,040

Loan-to-deposit ratio5 60.95% 59.69%

1 Securities investments comprise investment in securities and financial assets at fair value through profit or loss.

2 Interests in associates, deferred tax assets and derivative financial instruments are included in other assets.

3 Financial liabilities at fair value through profit or loss, derivative financial liabilities, debt securities in issue at amortised cost, current tax liabilities and

deferred tax liabilities are included in other accounts and provisions.

4 Subordinated liabilities comprise USD subordinated notes issued in 2010 and EUR subordinated loans granted by BOC in 2008.

5 The deposit base also includes structured deposits reported as “Financial liabilities at fair value through profit or loss”.



Balance Sheet Mix as at 30 June 2011 Balance Sheet Mix as at 31 December 2010

112,283 (6%) 419,231 (23%)

89,618 (5%)

441,973 (24%)719,500 (39%)

47,774 (3%)

88,854 (5%) 415,812 (25%)

39,499 (2%)

430,060 (26%)645,424 (39%)

41,391 (3%)

HK$’m/(%) HK$’m/(%)

Cash and balances with banks and other financial institutions

Placements with banks and other financial institutions maturing between one and twelve months

Securities investments

Advances and other accounts

Fixed assets and investment properties

Other assets

As at 30 June 2011, the Group’s total assets amounted to HK$1,830,379 million, up HK$169,339 million or 10.2% from

the end of 2010. The overall asset growth was primarily driven by the expansion of the Group’s core banking businesses

and RMB business in Hong Kong. Key changes include:

• Placementswith banks and other financial institutionsmaturing between one and twelvemonths increased by

HK$50,119 million, or 126.9%, mainly due to the growth in RMB placements with banks and other financial

institutions.

• Securities investments increased by HK$11,913 million or 2.8%, mainly due to the increase in investments in

government-related securities as well as high-quality financial institutions and corporate debts.

• AdvancesandotheraccountsrosebyHK$74,076millionor11.5%,whichwasmainlyattributabletothegrowth

in advances to customers by HK$59,639 million or 9.7%.

• OtherassetsgrewbyHK$15,959millionor38.1%,whichwasmainly ledby the increase inderivative financial

instruments and accounts receivable.

• Depositsandbalancesfrombanksandotherfinancial institutionsincreasedbyHK$73,120millionor23.3%,led

by the growth in interbank borrowing as well as RMB deposits from banks.



Advances to customers and deposits to customers*

200

600

1,000

1,400

0%

10%

20%

30%

40%

50%

60%

70%

2009.06.30

57.66%

HK$’bn

475.6

824.7

515.0

844.5

571.5

892.7

613.2

1,027.3

672.9

1,104.0

60.98%64.02%

59.69% 60.95%

Advances to Customers

2009.12.31 2010.06.30 2010.12.31 2011.06.30

Deposits from Customers Loan-to-deposit ratio

* Deposits from customers including structured deposits

Advances to Customers


At 30 June 2011 %

At 31 December

2010 %

Loans for use in Hong Kong 434,636 64.6 387,087 63.1

Industrial, commercial and financial 231,812 34.5 206,947 33.7

Individuals 202,824 30.1 180,140 29.4

Trade finance 59,840 8.9 53,396 8.7

Loans for use outside Hong Kong 178,382 26.5 172,736 28.2

Total advances to customers 672,858 100.0 613,219 100.0

The Group had adhered to a balanced growth strategy with regard to its loan book. It also strived to optimise the loan

portfolio structure and improve its pricing. As a result, the Group recorded a healthy loan growth of HK$59,639 million

or 9.7% to HK$672,858 million in the first half of 2011.

Loans for use in Hong Kong grew by HK$47,549 million or 12.3%.

• Lending to the industrial, commercial and financial sectors increased by HK$24,865 million, or 12.0%, to

HK$231,812 million, covering a wide range of industries. Notable growth was recorded in the lending to wholesale

and retail trade, property investment as well as transport and transport equipment.

• Residentialmortgage loans (excluding those under theGovernment-sponsoredHomeOwnership Scheme)were

up by HK$20,660 million, or 14.0%, to HK$168,084 million, as a result of the Group’s effective marketing efforts

in an active property market particularly in the first quarter of the year. The proportion of total new drawdown

in HIBOR-based residential mortgage loans increased as customers were more inclined to take advantage of low

interbank rates.

Trade finance rose by HK$6,444 million or 12.1%. Meanwhile, loans for use outside Hong Kong grew by HK$5,646 million

or 3.3%.



Deposits from Customers*


At 30 June 2011 %

At 31 December

2010 %

Demand deposits and current accounts 70,619 6.4 70,453 6.9

Savings deposits 522,972 47.4 528,035 51.4

Time, call and notice deposits 509,844 46.2 428,545 41.7

1,103,435 100.0 1,027,033 100.0

Structured deposits designated

at fair value through profit or loss 569 0.0 234 0.0

Deposits from customers 1,104,004 100.0 1,027,267 100.0

* including structured deposits

In the first half of 2011, the Group’s deposits from customers increased by HK$76,737 million, or 7.5%, to HK$1,104,004

million. Customers were inclined to shift their funds towards fixed deposits for higher interest rates amid the competition

among banks in Hong Kong. Time, call and notice deposits rose by HK$81,299 million or 19.0% to HK$509,844 million.

Savings deposits recorded a drop of HK$5,063 million or 1.0%. The Group’s loan-to-deposit ratio was up 1.26 percentage

points to 60.95% at the end of June 2011.

Loan Quality


At 30 June 2011

At 31 December

2010

Advances to customers 672,858 613,219

Classified or impaired loan ratio1 0.10% 0.14%

Impairment allowances 2,470 2,311

Regulatory reserve for general banking risks 6,595 5,076

Total allowances and regulatory reserve 9,065 7,387

Total allowances as a percentage of advances to customers 0.37% 0.38%

Impairment allowances2 on classified or impaired loan ratio 38.53% 40.02%

Residential mortgage loans3 – delinquency and rescheduled loan ratio4 0.01% 0.02%

Card advances – delinquency ratio4,5 0.15% 0.15%


2011

Half-year ended

30 June

2010

Card advances – charge-off ratio5,6 1.07% 1.56%

1 Classified or impaired loans represent advances which have been classified as “substandard”, “doubtful” or “loss” under the Group’s classification of loan

quality, or individually assessed to be impaired.

2 Referring to impairment allowances on loans classified as “substandard”, “doubtful” or “loss” under the Group’s classification of loan quality, or individually

assessed to be impaired.

3 Residential mortgage loans exclude those under the Home Ownership Scheme and other government-sponsored home purchasing schemes.

4 Delinquency ratio is measured by a ratio of total amount of overdue loans (more than three months) to total outstanding loans.

5 Excluding Great Wall cards and computed according to the HKMA’s definition.

6 Charge-off ratio is measured by a ratio of total write-offs made during the period to average card receivables during the period.



The Group’s loan quality remained sound, with the

classified or impaired loan ratio falling by 0.04 percentage

point to 0.10%. Classified or impaired loans decreased

by HK$161 million, or 18.6%, to HK$706 million mainly

due to collections and fewer new classified loans. New

classified loans in the first half of 2011 represented

approximately 0.03% of total loans outstanding.

Total impairment allowances, including both individual

assessment and collective assessment, amounted to

HK$2,470 million. Total impairment allowances in respect

of the classified or impaired loans as a percentage of total

classified or impaired loans accounted for 38.53%.

The quality of the Group’s residential mortgage loans

remained sound with the combined delinquency and

rescheduled loan ratio standing at a low level of 0.01%

at the end of June 2011. As compared to the first half

of 2010, the charge-off ratio of card advances dropped

by 0.49 percentage points to 1.07%, mainly due to

the cardholders’ improved debt servicing capability as

economic conditions improved.

Capital and Liquidity Ratios


At 30 June 2011

At 31 December

2010

Core capital 83,563 78,275

Deductions (791) (332)

Core capital after deductions 82,772 77,943

Supplementary capital 31,347 33,876

Deductions (791) (332)

Supplementary capital after deductions 30,556 33,544

Total capital base after deductions 113,328 111,487

Risk-weighted assets

Credit risk 561,273 648,236

Market risk 21,722 18,328

Operational risk 48,789 47,895

Capital floor adjustment 41,768 –

Deductions (30,230) (23,862)

Total risk-weighted assets 643,322 690,597

Capital adequacy ratios (consolidated basis)

Core capital ratio 12.87% 11.29%

Capital adequacy ratio 17.62% 16.14%


2011

Half-year ended

30 June

2010

Average liquidity ratio 36.38% 37.81%



The Group adopted the foundation internal ratings-based

(“FIRB”) approach to calculate credit risk and standardised

(credit risk) (“STC”) approach for certain credit exposures

being exempted from FIRB effective from 1 January

2011. The market risk of the Group mainly sourced from

BOCHK. BOCHK adopted the internal models approach

(“IMM”) to calculate general market risk for interest rate

and exchange rate exposures effective from 1 April 2011

while the Group continued to adopt the standardised

(market risk) (“STM”) approach to calculate the remaining

market risk. In addition, the Group continued to adopt

the standardised (operational risk) (“STO”) approach

for operational risk. The Group’s capital adequacy ratio

was calculated based on the various risk measurement

approaches above.

The Group adopted the STC approach and STM approach

to calculate credit risk and market risk respectively as

at 31 December 2010. As a result of the change in the

basis used, the amounts shown above are not directly

comparable.

Consolidated capital adequacy ratio of the banking group

at 30 June 2011 was 17.62%. The Group’s total capital

base expanded by 1.7% to HK$113,328 million mainly

due to the increase in retained earnings.

The average liquidity ratio in the first half of 2011

remained strong at 36.38%.

BuSINESS REvIEW

PERSONAl BANKINg

HK$’m


2011

Half-year ended

30 June

2010

Net interest income 2,843 2,932

Other operating income 2,720 2,384

Operating income 5,563 5,316

Operating expenses (2,754) (3,044)

Operating profit before impairment allowances 2,809 2,272

Net charge of loan impairment allowances (77) (37)

Others (9) (5)

Profit before taxation 2,723 2,230

At 30 June 2011

At 31 December

2010

Segment assets 237,746 210,978

Segment liabilities 656,172 657,605

Note: For additional segmental information, see Note 40 to the Interim Financial Information.

Financial Results

In the first half of 2011, the Group’s Personal Banking

business recorded a profit before taxation of HK$2,723

million, up HK$493 million or 22.1% year-on-year.

Operating income rose by 4.6%, driven mainly by the

increase in net fee and commission income. The increase

was, however, partially offset by a drop in net interest

income. Operating profit before impairment allowances

was HK$2,809 million, up 23.6%.

Net interest income decreased by 3.0% mainly because of

higher deposit costs despite a growth in average balance

of loans and advances. Other operating income rose by

14.1% on account of the strong growth in fee income

from insurance and fund distribution.



During the period, a more detailed and comprehensive

cost allocation mechanism was adopted. No change has

been made to the comparative figures. If the same cost

allocation mechanism is applied for the same period

last year, it is estimated that operating expenses in the

first half of 2011 would have increased by HK$179

million year-on-year. The increase was mainly due to

higher business-related expenses such as marketing and

promotional expenses.

Net charge of loan impairment allowances was HK$77

million, mainly due to impairment allowances made on

collective assessment. The increase was in line with the

expansion of loan balances.

Advances and other accounts, including mortgage loans

and card advances, increased by 12.3% to HK$220,649

million, while deposits from customers dropped by 0.3%

to HK$626,172 million.

Business operation

The Group managed to achieve solid growth in major

Personal Banking businesses in the first half of 2011. It

registered satisfactory growth in its residential mortgage

business with improved pricing of new HIBOR-based

mortgage loans. It also continued to enhance its securities

business platform with the newly established mobile

banking channel. Meanwhile, the Group strived to provide

more differentiated services to its wealth management

customers. The credit card business grew steadily in

terms of card issuance and merchant acquiring volume.

To meet customers’ demand for RMB banking products

and services, the Group expanded its product spectrum

substantially, thus reinforcing its premier position in Hong

Kong’s RMB banking business as a whole.

Robust growth of residential mortgages

The Group maintained its steady growth in the first half of

2011. It launched the “First-year HIBOR-based and Prime-

based afterwards” mortgage plan to meet customers’

needs. Meanwhile, the Group continued to strengthen

its strategic partnership with major property developers

and participated in joint promotions in most of the prime

property development projects. The Group’s outstanding

residential mortgage loans grew by 14.0% from the end

of 2010. In view of higher funding costs, the Group raised

the pricing of new HIBOR-based mortgage loans. The

credit quality of residential mortgages remained sound

under the Group’s rigorous risk assessment and control

over the mortgage business.

Further development of investment and insurance

businesses

The Group expanded its stock brokerage service

spectrum and embarked on a number of promotion

and marketing campaigns. With the support of the new

mobile banking service, stock brokerage volume through

this channel increased satisfactorily. As for the fund

distribution business, more RMB funds were introduced.

The phenomenal 237.1% growth in the Group’s retail

fund distribution volume was partly accounted for by the

professional consultation service on retail funds jointly

offered by the sales staff and the newly formed Investment

Product Specialist Team.

Regarding its Bancassurance business, the Group

maintained its competitive advantages by enhancing its

sales model, launching effective marketing campaigns

and implementing a multi-channel distribution strategy.

The financial planning model continued to expand with

encouraging results. There was robust growth in the sales

of insurance products. Meanwhile, more RMB insurance

products were introduced to meet the market’s demand.

The Group further improved its service quality. New

initiatives such as the customer satisfaction survey were

taken for the purpose of service enhancement.

Decent growth in credit card business

The Group’s card business sustained its growth momentum.

The total number of cards issued increased by 6.4% from

the end of 2010, while cardholder spending and merchant

acquiring volume rose by 26.2% and 38.4% respectively

year-on-year. The Group maintained its leadership in the

China UnionPay (“CUP”) merchant acquiring business and

CUP card issuing business, with merchant acquiring and

cardholder spending volume surging by 56.1% and 85.6%

respectively compared to the first half of 2010.

Riding on the success of “BOC CUP Dual Currency Credit

Card”, the Group introduced “BOC CUP Dual Currency

Commercial Card”, which is the first of its kind in Hong

Kong to use both RMB and HKD as the settlement

currencies for corporate customers. The Group’s success in

credit card business gained extensive market recognition,

as evidenced by a total of 30 awards received from

VISA International, MasterCard and China UnionPay

respectively.



The credit quality of the Group’s card advances remained

sound with the annualised charge-off ratio for the six

months period to 30 June 2011 standing at 1.07%.

Maintaining sound relationship with high potential

customers

To further expand its high net-worth customer base, the

Group strived to maintain long-term relationship with its

wealth management customers by providing differentiated

services and customising wealth management solutions

through different service channels. It organised

a range of marketing activities and provided various

market information to wealth management customers.

Under the “Customer Referral Programme” and “New

Customer Relationship Building Programme”, the Group

broadened its customer base by cross-selling with bundled

promotional offers. At the end of June 2011, the total

number of wealth management customers and their assets

maintained with the Group grew by 9.7% and 4.0%

respectively from the end of 2010.

Optimising distribution channels and enhancing

e-platform services

The Group continuously optimised its distribution channels

to meet cross-border and local customer needs. At the

end of June 2011, the Group’s service network in Hong

Kong comprised 266 branches, including 132 wealth

management centres and 21 dedicated Mainland customer

service centres. Furthermore, a new hotline was set up

specifically for providing enquiry services to Mainland

customers.

The Group further invested in the automated banking

service network to facilitate customers in using banking

services beyond normal banking hours. This included

installing newly designed ATM’s as well as cash and

cheque deposit machines with enhanced functions. To

strengthen its multi-currency deposit and withdrawal

services, the Group upgraded the cheque deposit machines

to accept RMB and USD cheques in addition to HKD ones.

This is the first of its kind in Hong Kong. The Group

also enhanced the functions of its e-Banking platform,

including the extension of FX and Bullion Margin trading

hours. Moreover, the internet functions were extended

to the mobile banking platform with good response. The

number of mobile banking users increased significantly

from the end of 2010.

In recognition of its well accepted electronic platform

and outstanding services, the Group was honoured with

the “Best Internet Banking” and “Best Mobile Telephone

Banking” awards of the Capital Weekly Service Awards

2011.

CORPORATE BANKINg

HK$’m


2011

Half-year ended

30 June

2010


Other operating income 1,622 1,464


Operating expenses* (1,371) (1,232)


Net reversal of loan impairment allowances 40 131

Others (1) –


At 30 June 2011

At 31 December

2010




* During the period, a more detailed and comprehensive cost allocation mechanism was adopted. No change has been made to the comparative figures.



Financial Results

Corporate Banking achieved a strong growth of HK$1,095

million or 32.6% in profit before taxation, which stood

at HK$4,453 million. Operating profit before impairment

allowances increased by 36.8% to HK$4,414 million. The

increase was mainly driven by the growth in net interest

income.

Net interest income increased by 39.0%, which was mainly

attributable to the increase in the average balance of loans

and deposits, and improved loan pricing. Other operating

income increased by 10.8%, led by the growth in fee

income from payment services and currency exchange, as

well as bills commission.

Operating expenses* would have increased by HK$135

million year-on-year, if the same cost allocation mechanism

is applied for the same period last year. The increase was

mainly due to higher business-related expenses and staff

costs.

Net reversal of loan impairment allowances decreased as

recoveries were lower.

Advances and other accounts increased by 10.9% to

HK$506,317 million, while deposits from customers grew

by 20.2% to HK$482,304 million.

* During the period, a more detailed and comprehensive cost allocation

mechanism was adopted. No change has been made to the comparative

figures.

Business Operation

The Group’s Corporate Banking business continued

with a balanced growth strategy in the first half of

2011. Corporate loans registered steady growth with

improvement in loan pricing. Besides, the Group focused

on providing a full range of financial services, including

cross-border financial services, to its core corporate

clients.

The Group’s RMB corporate banking business marked

solid development as a result of the introduction of a

broader range of relevant products and services as well as

aggressive marketing and promotion. The Group’s service

platform was further improved. Alert to clients’ needs,

the Group succeeded in reaching out to new clients and

capturing cross-selling opportunities for higher revenue.

At the same time, the Group adhered to its vigilant

risk management policy to ensure well-balanced and

sustainable growth.

Quality growth in corporate lending business

The demand for corporate loans continued to rise in

the first half of the year. The Group grasped the market

opportunity to grow its credit portfolio in a well-balanced

manner. It remained cautious in securing new loans and

focused more attention on the pricing of loans. The

effectiveness of this strategy is reflected in the healthy

growth of 8.5% in corporate lending and the improved

loan pricing and loan quality in the first six months. The

Group also maintained close collaboration with BOC

through the “Global Relationship Manager Programme”

and “Global United Facilities Arrangement” to better

serve its customers. In the first half of 2011, the Group

remained the top mandated arranger in the Hong Kong-

Macau syndicated loan market.

SME business registered steady development

The Group further grew its SME banking business by

participating in the “SME Financing Guarantee Scheme”

launched by the Hong Kong Mortgage Corporation

Limited as well as by enhancing its service model,

improving its product features and offering total solution

services to SME customers. Through closer collaboration

with BOC and NCB (China) and cooperation with major

trade associations, the Group continued to explore new

targeted customers. In May 2011, BOCHK received for the

fourth consecutive year the “SME’s Best Partner Award”

presented by the Hong Kong Chamber of Small and

Medium Business Limited.

Steady growth in trade finance and trade settlement

business

The flourishing of global trade fuelled the growth of

the Group’s trade finance business. The Group also

collaborated with BOC to offer cross-border trade finance,

such as the RMB agency payment services, to corporate

customers in both Hong Kong and the Mainland. In the

first half of 2011, the Group’s balance of trade finance

grew by 12.1% versus the end of 2010. Cross-border

trade settlement volume recorded a notable growth of

138% year-on-year.



Custody services making good progress

The custody business continued to expand in the first

half of 2011. The Group stepped up its sales efforts and

had successfully secured mandates to provide global

custody services to various Qualified Domestic Institutional

Investors and other institutions including major banks,

fund houses as well as insurance and securities companies

inside and outside Mainland. Custody of RMB investment

instruments was on the increase, and the Group continued

to provide escrow services to large corporate entities.

It also strengthened its relationship with its corporate

customers and actively sought business opportunities in

custody services. At the end of June 2011, excluding the

RMB fiduciary account, total assets under the Group’s

custody were valued at HK$481.7 billion, increasing by

4.7% over the end of 2010.

Expanding service spectrum in cash management

The Group made further progress in developing its cash

management business. New services were introduced to

drive growth and to enhance the Group’s competitiveness.

In conjunction with the implementation of the local

interbank RMB autopay system by the Hong Kong

Interbank Clearing Limited in March 2011, the Group

rolled out a wide range of RMB payment and receivable

products. The Group also launched the cross-border RMB

bill payment service which allows merchants in Shenzhen

to collect RMB bill payments from bank accounts in Hong

Kong. At the same time, the Group strengthened the

linkage of its cash management service platform with

those of BOC and its overseas branches. With effective

marketing, the number of Corporate Banking Services

Online (“CBS Online”) customers increased by 12.4%

over the end of 2010.

Proactive measures in risk management

The Group remained persistently vigilant over risk

management. Stringent credit control was in place to

safeguard asset quality. The Group closely monitored those

corporate customers who could be adversely affected by

rising production costs in the Mainland, RMB appreciation,

upsurge in commodity prices, and emerging risks in Japan

and the European region.

MAINlAND BuSINESSSteady growth of Mainland business

The Group’s Mainland business recorded satisfactory

growth in the first half of 2011. During the period,

the Group focused on strengthening its deposit base

to support long-term development. Customer deposits

grew by 34.9% while advances to customers registered

a 1.2% drop, thus resulting in an improvement in its

loan-to-deposit ratio. The Group also strived to enlarge

its customer base by strengthening its customer service

capability and enriching its range of RMB wealth

management products for Mainland customers.

Further development in distribution channels and

branch network

The expansion of the Group’s network in the Mainland

continued. NCB (China)’s Beijing Zhongguancun sub-

branch commenced operation on 1 March 2011. The

Group’s total number of branches and sub-branches in

the Mainland increased to 26 at the end of June 2011.

Meanwhile, NCB (China) has been approved by the China

Banking Regulatory Commission (“CBRC”) to establish

the Foshan sub-branch and the Qingdao Development

Zone sub-branch. Furthermore, the Group upgraded the

platform and functionality of its internet banking channel

to enhance customer experience. The improved corporate

internet banking was launched during the interim period,

while the new personal internet banking would commence

in the second half of 2011.



TREASuRy

HK$’m


2011

Half-year ended

30 June

2010


Other operating income 752 35


Operating expenses* (323) (330)


Net reversal of impairment allowances on securities investments 43 72


At 30 June 2011

At 31 December

2010




Financial Results

The Treasury segment’s profit before taxation rose by

35.3% year-on-year to HK$2,865 million in the first half

of 2011. Operating profit before impairment allowances

increased by 37.9% to HK$2,822 million, driven by

improvements in both net interest income and other

operating income.

Net interest income rose by 2.2%, which was mainly

attributable to the growth of RMB business with improved

asset yield. The substantial rise in other operating income

resulted mainly from higher net trading gain from foreign

exchange and related products and mark-to-market

change of certain interest rate instruments.

Operating expenses* would have decreased by HK$57

million, if the same cost allocation mechanism is applied

for the same period last year.

* During the period, a more detailed and comprehensive cost allocation

mechanism was adopted. No change has been made to the comparative

figures.

Business Operation

Enhancing investment portfolio management

In the face of various uncertainties in the financial market,

the Group proactively managed its banking book. The

Group took advantage of the steepening yield curve

and continued to invest in fixed rate debt securities, in

particular government-related securities as well as high-

quality financial institution and corporate bonds. The

Group disposed of lower-yielding securities to improve the

asset-liability structure. Furthermore, in order to capture

the opportunities arising from the expansion of the RMB

investment market, the Group took initiative to develop

the RMB bond business in the Mainland.

The Group remained vigilant in managing its portfolio.

In respect of the exposure to the European countries

affected by the debt crisis, namely Portugal, Ireland, Italy,

Greece and Spain, the Group only had exposure to debt

securities issued by financial institutions of Ireland and

Italy amounting to a total of HK$1,002 million as at the

end of June 2011 (versus HK$1,238 million at the end

of 2010).



Growing traditional and RMB-related businesses

The Group continued to strengthen its traditional product

offering by improving its customer service quality and

optimising the Investment Product Specialist Team for

the high net-worth customer group. In addition, the

Group’s strategy of focusing on RMB-related business

continued to yield promising results. The Group recorded

robust growth in foreign exchange income. With regard

to the RMB clearing bank business in Hong Kong, a

major development was that the RMB Fiduciary Account

Service was introduced to help Participating Banks to

better manage their credit exposure to the Clearing

Bank. The Group also launched securities sale and

repurchase facilities (RMB Repo Facilities) through the

Central Moneymarkets Unit to facilitate intraday liquidity

management of Participating Banks. Meanwhile, following

the establishment of the asset management platform

towards the end of last year, the Group launched the

“BOCHK RMB Bond Fund” targeting high net-worth

customers. The Group also cooperated with BOC’s

overseas branches to build up a global RMB banknote

network while providing product support and price-

quoting services to those branches.

INSuRANCE

HK$’m


2011

Half-year ended

30 June

2010

Net interest income 847 724

Gross earned premiums 6,530 2,813

Gross earned premiums ceded to reinsurers (3,133) (11)

Other operating income 399 559


Net insurance benefits and claims (4,220) (3,875)

Net operating income 423 210

Operating expenses (101) (104)

Operating profit before impairment allowances 322 106

Net charge of impairment allowances on securities investments (31) –

Profit before taxation 291 106

At 30 June 2011

At 31 December

2010




Financial Results

The Group’s Insurance segment recorded strong financial

results in the first half of 2011. Profit before taxation grew

by 174.5% to HK$291 million. The increase was mainly

attributable to the improved underwriting profit and the

success of the RMB product strategy.

Net interest income rose by 17.0% mainly due to the

increase in debt securities investments made for the new

premiums received. Gross insurance premium income rose

considerably by 132.1% of which regular premium income

accounted for a significant part. Net insurance benefits

and claims, which reflect changes in policy reserves, rose

by 8.9%. The increase was mainly caused by the overall

growth of the insurance business.

Assets in the insurance segment grew by 10.4% with the

increase in both debt and equity securities investments

made for the new premiums. Liabilities rose by 10.4%,

which reflected the corresponding increase in insurance

contractual liabilities.



Business Operation

Further enhancement in product mix, service quality

and market share

The Group maintained its growth momentum in the

insurance business. The Group continued to focus on

its regular-premium products. The flagship products –

“Target 5 Years Insurance Plan Series” and “Multi-Plus

Savings Insurance Plan” – registered strong sales. New

products such as “Tactics Investment Insurance Plan”

and “Well-Assure Refundable Accident Insurance Plan”

were launched during the first half of 2011. The Group

also enhanced its service by strengthening the quality and

speed of the compensation and underwriting process.

Through the optimisation of product mix and service

quality, the Group further reinforced its market position

and expanded its market share.

Maintaining leading position in RMB insurance

products

In response to the strong market demand, the Group

developed and introduced more RMB insurance products

in the interim period, including the new RMB series of its

popular plans, such as the “Target 5 Years Insurance Plan

Series” and “Multi-Plus Savings Insurance Plan”, which

were well-received by customers. This further solidified the

Group’s leadership role in the RMB insurance market.

RISK MANAgEMENTBanking GroupOverview

The Group believes that sound risk management is crucial

to the success of any organisation. In its daily operation,

the Group attaches a high degree of importance to risk

management and emphasises that a balance must be

struck between risk control and business growth and

development. The principal types of risk inherent in the

Group’s businesses are credit risk, interest rate risk, market

risk, liquidity risk, operational risk, reputation risk, legal

and compliance risk, and strategic risk. The Group’s risk

management objective is to enhance shareholder value by

maintaining risk exposures within acceptable limits. The

Group has a defined risk appetite statement approved by

the Board, which is an expression of the types and level

of risk that the Group is willing to take in order to achieve

its business goals and to meet the expectations of its

stakeholders under a controllable risk level.

Risk Management governance Structure

The Group’s risk management governance structure is

designed to cover all business processes and ensure

various risks are properly managed and controlled in

the course of conducting business. The Group has a

robust risk management organisational structure with a

comprehensive set of policies and procedures to identify,

measure, monitor and control various risks that may

arise. These risk management policies and procedures

are regularly reviewed and modified to reflect changes

in markets and business strategies. Various groups of

risk takers assume their respective responsibilities for risk

management.

The Board of Directors, representing the interests of

shareholders, is the highest decision-making authority

of the Group and has the ultimate responsibility for

risk management. The Board, with the assistance of

its committees, has the primary responsibility for the

formulation of risk management strategies and for

ensuring that the Group has an effective risk management

system to implement these strategies. The Risk Committee

(“RC”), a standing committee established by the Board

of Directors, is responsible for overseeing the Group’s

various types of risks, reviewing and approving high-level

risk-related policies and overseeing their implementation,

reviewing significant or high risk exposures or transactions

and exercising its power of veto if it considers that any

transaction should not proceed. The Audit Committee

assists the Board in fulfilling its role in overseeing the

internal control system.

The Chief Executive (“CE”) is responsible for managing

the Group’s various types of risks, approving detailed

risk management policies, and approving material risk

exposures or transactions within his authority delegated

by the Board of Directors. The Chief Risk Officer (“CRO”)

assists the CE in fulfilling his responsibilities for the day-

to-day management of risks. The CRO is responsible for

initiating new risk management strategies, projects and

measures that will enable the Group to better monitor and

manage new risk issues or areas that may arise from time

to time from new businesses, products and changes in

the operating environment. He may also take appropriate

initiatives in response to regulatory changes. The CRO is

also responsible for reviewing material risk exposures or



transactions within his delegated authority and exercising

his power of veto if he believes that any transaction

should not proceed.

Various units of the Group have their respective risk

management responsibilities. Business units act as the first

line of defence while risk management units, which are

independent from the business units, are responsible for

the day-to-day management of different kinds of risks. Risk

management units have the primary responsibilities for

drafting, reviewing and updating various risk management

policies and procedures.

The Group’s principal banking subsidiaries, Nanyang, NCB

(China) and Chiyu, are subject to risk policies that are

consistent with those of the Group. These subsidiaries

execute their risk management strategies independently

and report to the Group’s management on a regular

basis.

Credit Risk Management

Credit risk is the risk of loss that a customer or counterparty

will be unable to or unwilling to meet its contractual

obligations. Credit risk exists in the trading book and

banking book, on– and off-balance sheet exposures

of a bank. It arises principally from the lending, trade

finance and treasury businesses, and covers inter-bank

transactions, foreign exchange and derivative transactions

as well as investments in bonds and securities. The Chief

Credit Officer, who reports directly to the CRO, takes

charge of credit risk management and is also responsible

for the control of credit risk exposure of subsidiaries

in line with the credit risk management principles and

requirements set by the Group. The Chief Analytics Officer,

who also reports directly to the CRO, is responsible for the

development and maintenance of internal rating models

and rating criteria. For loans and advances to customers,

different credit approval and control procedures are

adopted according to the level of risk associated with

the customer, counterparty or transaction. The Credit

Risk Assessment Committee comprising experts from

the Group’s credit and other functions is responsible for

making an independent assessment of all credit facilities

which require the approval of Deputy Chief Executives

or above. Corporate and financial institution credit

applications are independently reviewed and objectively

assessed by risk management units. Obligor ratings and

facility grades are assigned to these portfolios. Retail

internal rating systems are deployed in the risk assessment

of retail credit transactions, including small business retail

exposures, residential mortgage loans, personal loans and

credit cards. Obligor ratings as well as loss estimates (if

applicable) are used to support credit approval.

The Group identifies credit concentration risk by industry,

geography, customer and counterparty risk. The Group

monitors changes to counterparties’ credit risk, the quality

of the credit portfolio and risk concentrations, and reports

regularly to the Group’s management

The Group uses loan grades, obligor ratings and loss

estimates (if applicable) to support credit monitoring,

analysis and reporting. For corporate and financial

institutions, more frequent rating review and closer

monitoring are required for riskier customers. For retail

exposures, monthly updated ratings and loss estimates

are used for credit monitoring on a portfolio basis. More

comprehensive review is required for obligors being

identified under high-risk pools. The Group has established

a master scale for internal credit rating purpose, which is

in compliance with the Banking (Capital) Rules on rating

structure. In addition to obligor ratings, the Group adopts

a facility rating system to assess the risk in the facility

structure during credit approval. This two-dimensional

rating approach to evaluate credit risk complies with the

HKMA’s requirement on IRB.

As of 30 June 2011, the Group continues to adopt

loan grading criteria which divide credit assets into 5

categories with reference to HKMA’s guidelines. The Risk

Management Department (“RMD”) provides regular credit

management information reports and ad hoc reports to

the Management Committee, RC and Board of Directors

to facilitate their continuous monitoring of credit risk.

For investments in debt securities and securitisation assets,

the obligor ratings or external credit ratings, assessment

of the underlying assets and credit limits setting on

customer/security issuer basis are used for managing

credit risk associated with the investment. For derivatives,

the Group sets customer limits to manage the credit

risk involved and follows the same approval and control

processes as applied for loans and advances. Ongoing

monitoring and stop-loss procedures are established.



The Group adopts a comprehensive methodology in

determining whether a particular asset/mortgage-backed

security (“ABS/MBS”) is impaired. Under the methodology,

the Group will take into consideration not only the mark-

to-market (MTM) price of the issue and its external credit

rating, but also additional factors such as FICO score,

vintage, location, adjustable rate mortgage (“ARM”)

status, delinquencies, level of collateral protection, loan-

to-value ratio and prepayment speed of the underlying

assets. Furthermore, having considered these factors, the

ABS/MBS issue has to further pass the required credit

enhancement coverage ratio set by the Group. This ratio is

determined by applying assumptions regarding the default

rates based on the available delinquency, foreclosure and

real estate owned (“REO”) data of the ABS/MBS issue.

Interest Rate Risk Management

Interest rate risk means the risk to a bank’s earnings

and economic value arising from adverse movements in

interest rate and term structures of the bank’s asset and

liability positions. The Group’s interest rate risk exposures

are mainly structural. The major types of interest rate risk

from structural positions are:

• Repricing risk – mismatches in the maturity or

repricing periods of assets and liabilities that may

affect net interest income;

• Basis risk – different pricing basis for different

transactions so that the yield on assets and cost of

liabilities may change by different amounts within

the same repricing period;

• Yield curve risk – non-parallel shifts in the yield

curve that may have an adverse impact on net

interest income or economic value;

• Option risk – exercise of the options embedded

in assets, liabilities or off-balance sheet items that

can cause a change in the cashflows of assets and

liabilities.

The Group has set out interest rate risk indicators and

limits to identify, measure, monitor and control interest

rate risk. The indicators and limits include, but are not

limited to, re-pricing gap limits, basis risk, duration, price

value of a basis point (PVBP), Greeks, net interest income

sensitivity ratio, economic value sensitivity ratio (including

sub-limit for AFS securities), etc.

The indicators and limits are classified into two levels,

which are approved by the RC and ALCO respectively.

Risk-taking business units are required to conduct their

business within the boundary of the interest rate risk limits.

Before launching a new product or business in the banking

book, relevant departments are required to go through

a risk assessment process, which includes assessment

of underlying interest rate risk and consideration of the

adequacy of current risk monitoring mechanism. Any

material impact on interest rate risk noted during the risk

assessment process will be reported to both the CFO and

CRO and submitted to the RC for approval.

Net interest income (NII) sensitivity ratio and economic

value (EV) sensitivity ratio assess the impact of interest rate

movement on the Group’s net interest income and capital

base. They are the Group’s key interest rate risk indicators.

The former assesses the impact of interest rate movement

on net interest income as a percentage to budgeted

net interest income for the year. The latter assesses the

impact of interest rate movement on economic value (i.e.

the present value of cash-flows of assets, liabilities and

off-balance-sheet items discounted using market interest

rate) as a percentage to the latest capital base. Limits are

set by RC on these two indicators to monitor and control

the Group’s banking book interest rate risk.

The Group uses scenario analysis and stress test to assess

the banking book interest rate risk the Group would face

under adverse circumstances. Scenario analysis and stress

test are also devised to assess the impact on net interest

income and economic value as well as capital base arising

from the optionality of demand and savings deposits,

the prepayment of mortgage loans and the prepayment

of ABS/MBS due to extension/contraction of weighted

average life.

Market Risk Management

Market risk refers to the risk of losses arising from

adverse movements in the value of foreign exchange and

commodity positions and the trading book interest rate

and equity positions held by the Group due to the volatility



of financial market prices (debt security price/interest rate,

foreign exchange rate, equity price, commodity price).

The Group adopts robust market risk appetite to achieve

balance between risk and return. The Group’s objective in

managing market risk is to secure healthy growth of the

treasury business, by effective management of potential

market risk in the Group’s business, according to the

Group’s overall risk appetite and strategy of the treasury

business and based on well-established risk management

regime and measures.

With regard to the corporate governance of risk

management, the Board and Risk Committee, senior

management and functional departments/units perform

their respective duties and responsibilities to manage the

Group’s market risk. The Risk Management Department

(Market Risk Management) is mainly responsible for

managing market risk, assisting senior management to

perform their day-to-day duties, independently monitoring

the market risk profile and compliance of management

policies and limits of the Group and BOCHK, and ensuring

that the aggregate and individual market risks are within

acceptable level.

The Group’s market risk management framework

covers the Group’s subsidiaries. The Group establishes

uniform market risk management policies to regulate

the Group’s and subsidiaries’ market risk management

work; meanwhile, the Group sets up the Group VAR

limit, which is allocated and monitored across the Group,

according to subsidiaries’ business requirements and

risk tolerance level. In line with the requirements set in

the Group policy, subsidiaries should formulate detailed

regulations (subject to prior consent by BOCHK) and must

bear the responsibility of managing the daily market risk

of the institution. Subsidiaries set up independent risk

monitoring teams to monitor daily market risk and limit

compliance, and submit management information and

reports to BOCHK on a regular basis.

The Group sets up market risk indicators and limits to

identify, measure, monitor and control market risk. Major

risk indicators and limits include but are not limited

to VAR, Stop Loss, Open Position, Stress Testing and

Sensitivity Analysis (Basis Point Value, Greeks), etc. To

meet management requirements, major risk indicators

and limits are classified into three levels, and approved

by the Risk Committee, Management Committee or

CRO and Deputy Chief Executive (DCE) in charge of

treasury business respectively. The treasury business units

of BOCHK and other subsidiaries (as for Group Limit) are

required to conduct their business within approved market

risk indicators and limits.

VAR refers to the core indicator used in managing the

Group’s market risk. It is a statistical method used to

measure the maximum loss of trading book positions held

by the bank over a target horizon with a given level of

confidence. The Group adopts a uniform VAR calculation

model, using the historical simulation approach and two

years’ historical data, to calculate VAR of the Group and

subsidiaries over a one-day holding period with a 99%

confidence level, and set up VAR limit of the Group and

subsidiaries.

The predictive power of the VAR measure is monitored by

back-testing, which compares the calculated VAR figure

of those trading positions of each business day with the

actual revenues arising on those positions on the next

business day. These actual revenues exclude non-trading

income, such as fee and commission. If back-testing

revenues are negative and exceeding the VAR, a “back-

testing exception” is noted. Generally speaking, the

number of back-testing exceptions in a rolling 12-month

period will not exceed four times. Back-testing results are

reported to the Group’s senior management, including

the CE and CRO. BOCHK conducts backtesting of VAR

measures on a monthly basis.

Although a valuable guide to risk, VAR should always be

viewed in the context of its limitations. For example:

• theuseofhistoricaldataasaproxyforestimating

future events may not encompass all potential

events, particularly those which are extreme in

nature;

• theuseofaone-dayholdingperiodassumesthat

all positions can be liquidated or hedged in one

day. This may not fully reflect the market risk

arising at times of severe illiquidity, when a one-

day holding period may be insufficient to liquidate

or hedge all positions fully;



• the use of a 99 per cent confidence level, by

definition, does not take into account losses that

might occur beyond this level of confidence; and

• VAR is calculated on the basis of exposures

outstanding at the close of business and therefore

does not necessarily reflect intraday exposures.

The Group recognises these limitations by formulating

stress test indicators and limits to assess and manage

the market risk uncovered by VAR. The stress testing

programme of the trading book includes sensitivity testing

on changes in risk factors with various degrees of severity,

as well as scenario analysis on historical events, including

the 1987 Equity Market Crash, 1994 Bond Market Crash,

the 1997 Asian Financial Crisis, the 2001 September 11

incidents and the 2008 Global Financial Crisis, etc.

HKMA has approved BOCHK to adopt an internal model

to calculate general market risk capital charge for the

risk categories of interest rates and exchange rates. The

approval has become effective on 1 April 2011.

liquidity Risk Management

Liquidity risk is the risk that banks fail to provide sufficient

funds to grow assets or pay due obligations, and so

need to bear an unacceptable loss. The Group adopts

a sound liquidity risk appetite to provide stable, reliable

and adequate sources of cash to meet liquidity needs

under normal circumstances or stressed scenarios; and

survive with net positive cumulative cash flow in extreme

scenarios without requesting HKMA to act as the lender

of last resort.

The Group’s liquidity risk management objective is to

effectively manage the liquidity of on-balance sheet and

off-balance sheet items with reasonable cost based on

the liquidity risk appetite to achieve sound operation

and sustainable profitability. According to different term

maturities and the results of funding needs estimated

from stressed scenarios, the Group adjusts its asset

structure (including loans, bond investments, interbank

placements, etc.) to maintain sufficient liquid assets in

support of normal business needs and ensure its ability to

raise enough funds at reasonable costs to serve external

claims in case of emergency. The Group is committed

to diversifying the source of funds and the use of funds

to avoid excessive concentration of assets and liabilities

and prevent triggering liquidity risk due to the break of

funding strand when problems occur in one concentrated

funding source. The Group also pays attention to liquidity

risk created by off-balance sheet activities, such as loan

commitments, derivatives, options and other complex

structured products. The Group has an overall liquidity risk

management strategy to cover the liquidity management

of foreign currency assets and liabilities, intraday liquidity,

intra-group liquidity, the liquidity risk arising from others’

risk, etc., and has formulated a corresponding funding

contingency plan.

The Group establishes liquidity risk management indicators

and limits to identify, measure, monitor and control

liquidity risk. Such indicators and limits include (but are

not limited to) liquidity ratio, deposit stability ratio, loan-

to-deposit ratio, Maximum Cumulative Outflow (“MCO”)

and liquidity buffer asset portfolio. The Group applies

cash flow analysis (under normal and stress conditions)

and liquidity stress test (including institution-specific

and worldwide crisis) to assess the Group’s capability to

withstand various severe liquidity crises. Also, the Assets

and Liabilities Management System (“ALM”) is developed

to provide data support for facilitating the liquidity risk

management duties.

The Group’s liquidity risk management also covers new

product or business development. Before launching

a new product or business, the relevant departments

are required to go through a risk assessment process,

which includes the assessment of underlying liquidity

risk and consideration of the adequacy of the current

risk management mechanism. Any material impact on

liquidity risk noted during the risk assessment process will

be reported to RC for approval.

The Group has established a set of uniform liquidity

risk management policies which serve as standards and

guidance to all the Group’s members for liquidity risk

management. On the basis of the Group’s uniform policy,

each of the subsidiaries formulates its own liquidity

management policies according to its own characteristics

(subject to prior consent by BOCHK), and assumes its own

liquidity risk management responsibility. Subsidiaries are

required to report their respective liquidity positions on a

regular basis to the Risk Management Department (Market

Risk Management) of BOCHK which consolidates such

information and monitors group-wide liquidity risk.



Operational Risk Management

Operational risk is the risk of loss resulting from inadequate

or failed internal process, staff and information technology

system, or from external events. The risk is inherent in

every aspect of business operations and confronted by the

Bank in its day-to-day operational activities.

The Group has put in place an effective internal control

process which requires the establishment of policies

and control procedures for all the key activities. Proper

segregation of duties and authorisation is the fundamental

principle followed by the Group. Corporate-level policy

and procedure on operational risk management are

formulated by the Operational Risk & Compliance

Department (“OR&CD”) and approved by RC.

The Group has adopted the “Three Lines of Defence”

model for its operational risk management governance

structure: all departments as the first line of defence are

the owner of operational risk and are responsible for

carrying out the duties and functions of self-risk control in

the process of business operation through self-assessment,

self-checking and self-correction. OR&CD together with

certain specialist functional units in relation to operational

risk management within the Group are the second

line of defence, which is responsible for assessing and

monitoring the operational risk condition of the first line

of defence, and providing them with guidance. In addition

to formulating the operational risk management policy

and procedure, OR&CD, being independent from business

units, is the central management unit of the Group’s

operational risk management and also responsible for

designing the operational risk assessment methodologies,

tools and the reporting mechanism (including the capturing

of data on operational risk events loss), monitoring

the implementation status of policies and operational

procedures in the departments of the first line of defence

through operational risk management tools, and assessing

and reporting the overall operational risk position to

Management and RC. Certain specialist functional units,

including the Human Resources Department, Information

Technology Department, Corporate Services Department,

OR&CD, Financial Management Department and General

Accounting & Accounting Policy Department, are required

to carry out their managerial duties of the second line

of defence with respect to some specific aspects of

operational risk. Besides taking charge of operational

risk management in their own units, these units are

also required to provide other units with professional

advice/training in respect of certain operational risk

categories and to lead the corporate-level operational risk

management. Audit Department is the third line of defence

which provides independent assessment with respect

to the operational risk management framework and is

required to conduct periodic audit of the operational risk

management activities of various departments/business

units within the Group regarding their compliance and

effectiveness and to put forward recommendations for

corrective actions.

The Group adopts the tools or methodologies such as

key risk indicators, self-assessment, operational risk

events reporting and review to identify, assess, monitor

and control the risks inherent in business activities and

products, as well as takes out insurance to mitigate

unforeseeable operational risks. Business continuity plans

are in place to support business operations in the event of

an emergency or disaster. Adequate backup facilities are

maintained and periodic drills are conducted.

Reputation Risk Management

Reputation risk is the risk that negative publicity regarding

the Group’s business practices, whether genuine or not,

will cause a potential decline in the customer base or lead

to costly litigation or revenue erosion. Reputation risk is

inherent in every aspect of business operation and covers

a wide spectrum of issues.

In order to mitigate reputation risk, the Group has

formulated and duly followed its Reputation Risk

Management Policy. The policy aims to prevent and

manage reputation risk proactively at an early stage when

an incident occurs. Since reputation risk is often caused

by various types of operational and strategic issues that

may have a negative impact on the trust in and perception

of the company, all operational and key risks identified

are assessed through the established KCSA framework

to evaluate the severity of their impact on the Group,

including the damage to reputation. In addition, the

Group has put in place a framework including system

support to achieve continuous monitoring of external

reputation risk incidents and published failures of risk

incidents in the financial industry.



legal and Compliance Risk Management

Legal risk is the risk that unenforceable contracts, lawsuits

or adverse judgments may disrupt or otherwise negatively

affect the Group’s operation or financial condition.

Compliance risk is the risk of legal or regulatory sanctions,

financial loss, or loss to reputation that the Group may

suffer as a result of any failure to comply with all

applicable laws and regulations. Legal and compliance

risks are managed by OR&CD, which reports directly to the

CRO. All legal matters are handled by the Legal Services

Centre (“LSC”), which reports to the Chief Operating

Officer. OR&CD is responsible for legal risk management

of the Group with support rendered by LSC. As part of

the Group’s corporate governance framework, policy for

the management of legal and compliance risk is approved

by the Risk Committee.

Strategic Risk Management

Strategic risk generally refers to the risks that may induce

immediate or future negative impact on the financial and

market positions of the Group because of poor strategic

decisions, improper implementation of strategies and lack

of response to the market. The Board of Directors reviews

and approves the policy for the management of strategic

risks. Key strategic issues have to be fully evaluated and

properly endorsed by the senior management and the

Board.

The Group will regularly review its business strategies to

cope with the latest market situation and developments.

Capital Management

The major objective of the Group’s capital management is

to maximise total shareholders’ return while maintaining a

capital adequacy position in relation to the Group’s overall

risk profile. The Group periodically reviews its capital

structure and adjusts the capital mix where appropriate.

ALCO monitors the Group’s capital adequacy. The Group

has complied with all the statutory capital standards for

the reported period.

To comply with HKMA’s requirements as stated in the

Supervisory Policy Manual “Supervisory Review Process”,

the Group has established the Internal Capital Adequacy

Assessment Process (ICAAP) and reviews it annually.

Using the statutory minimum CAR, 8%, as a starting

point, extra capital (capital add-on) needed to cover the

risks not captured under Pillar I is assessed. A Scorecard

approach based on HKMA’s compliance guidance on

Pillar II has been used to evaluate the Group’s risk

profile in order to assess the add-on capital in Pillar

II to the regulatory capital under Pillar I to determine

the minimum CAR. An Operating CAR Range has also

been established which incorporates the need for future

business growth and efficiency of capital utilisation. In

response to the core capital requirements under Basel

III Accord, minimum common equity CAR and minimum

core CAR are introduced in 2011’s ICAAP. As the Group

has adopted Foundation Internal Ratings-Based (“FIRB”)

approach in its calculation of credit risk since 2011, all

capital adequacy targets are determined based on FIRB

approach.

Stress Testing

The Group supplements the analysis of various types of

risks with stress testing. Stress testing is a risk management

tool for estimating the Group’s risk exposures under

stressed conditions arising from extreme but plausible

market or macroeconomic movements. These tests are

conducted on a regular basis by various risk management

units and ALCO monitors the results against limits

approved by RC. The Financial Management Department

reports the combined stress test results to the Board and

RC regularly.

BOC Life InsuranceThe principal activity of BOC Life’s business is the

underwriting of long-term insurance business in life and

annuity, unit-linked long-term business and retirement

scheme management in Hong Kong. Major types of

risk arising from the BOC Life’s insurance business are

insurance risk, interest rate risk, liquidity risk and credit

risk. BOC Life closely monitors these risks independently

and reports to its RC on a regular basis. The key risks of

its insurance business and related risk control processes

are as follows:

Insurance Risk Management

BOC Life is in the business of insuring against the risk of

mortality, morbidity, disability, critical illness, accidents

and related risks. BOC Life manages these risks through

the application of its underwriting policies and reinsurance

arrangement.



The underwriting strategy is intended to set premium

pricing at an appropriate level that corresponds to the

underlying exposure of the risks underwritten. Screening

processes, such as the review of health condition and

family medical history, are also included in BOC Life’s

underwriting procedures.

Within the insurance process, concentrations of risk

may arise where a particular event or series of events

could impact heavily upon BOC Life’s liabilities. Such

concentrations may arise from a single insurance contract

or through a small number of related contracts, and relate

to circumstances where significant liabilities could arise.

For in-force insurance contracts, most of the underlying

insurance liabilities are related to endowment and unit-

linked insurance products. For most of the insurance

policies issued, BOC Life has a retention limit on any

single life insured. BOC Life cedes the excess of the

insured benefit over the limit for standard risks (from a

medical point of view) to reinsurer under an excess of loss

reinsurance arrangement.

Uncertainty in the estimation of future benefit payments

and premium receipts for long-term insurance contracts

arises from the unpredictability of long-term changes in

overall levels of mortality and persistency. In order to

assess the uncertainty due to the mortality assumption

and lapse assumption, BOC Life conducts mortality study

and lapse study in order to determine the appropriate

assumptions. In these studies, consistent results are

reflected in both assumptions with appropriate margins.

Interest Rate Risk Management

An increase in interest rates may result in the depreciation

of the value of the bond portfolio. It may also result

in customers accelerating surrenders. A decrease in

interest rates may result in an inability to adequately

match guarantees or lower returns leading to customer

dissatisfaction. BOC Life manages the asset liability

matching of its portfolios within an asset liability

management framework that has been developed to

achieve investment returns that match its obligations

under insurance contracts.

liquidity Risk Management

Liquidity risk is the risk of not being able to fund increases

in assets or meet obligations as they fall due without

incurring unacceptable loss. BOC Life’s asset liability

matching framework includes cash flow management to

preserve liquidity to match policy payout from time to

time. In the normal course of BOC Life’s business, new

business premiums generate constant cash inflows and, as

a result, the portfolios also grow gradually to meet future

liquidity requirement.

Credit Risk Management

BOC Life has exposure to credit risk, which is the risk that

a customer or counterparty will be unable to or unwilling

to meet a commitment that it has entered into. Key

areas to which BOC Life’s insurance business is exposed

include:

• Defaultriskofbondissuersorthecounterparties

of structured products

• Credit spread widening as a result of credit

migration (downgrade)

• Re-insurers’shareofinsuranceunpaidliabilities

• Amountsduefromre-insurersinrespectofclaims

already paid

• Amountduefrominsurancecontractholders

• Amountduefrominsuranceintermediaries

BOC Life manages credit risk by placing limits on its

exposure to each investment counterparty or group of

counterparties. Such limits are subject to annual or more

frequent review by the management.

In order to enhance credit risk management, BOC Life

has strengthened its communication with the Investment

Management of the Group and closely monitors and

updates the established Disposal and Watch Lists to ensure

consistency with the Group’s credit risk management and

investment strategy.

management’s discussion and analysis · interim report 2011 boc hong kong (holdings) limited 11...

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